Just over a week ago, Nomura's Charlie McElligott warned - amid volatility doldrums and incessantly dip-buying stock gains - that the party could end next Friday (today) as the quad witch combined with realized risk windows shifting would lead to a notable increase in volatility.
Given the surge in vol and chaotic trading of the last three days (and more to come today), he nailed it...
And now he is warning that "Reflation" expressions are being de-grossed and even outright liquidated, as the tidal wave of the Fed’s own perceived “FIAT flinch” crescendos into a reversal of YTD macro-trends - with “official taper” pile-on from Fed’s Bullard just now (*BULLARD: CHAIR POWELL OFFICIALLY OPENED TAPER DISCUSSION AT LAST MEETING, MORE IN DEPTH DISCUSSION TO FOLLOW) adding into what we already anticipated to be a potential “Op-Ex unclenching,” thanks to today’s outlier $Gamma and $Delta declines in US Equities Index / ETF options.
Because it now seems apparent that the Fed’s conviction in their own purportedly flexible “average inflation targeting” framework could not withstand their fears surrounding the “right tail” trajectory of inflation (and with FOMC forecasts now apparently implying that inflation will have already averaged above 2% for 2021—that’s a weak “mission accomplished” for the “run hot” perspective!!!), particularly as doubts grew on their own prior “transitory” rationale—and as such, the surge in the SEP ‘23 Fed Funds dots has been interpreted as an indication that there is now a “cap” on inflation overshoot / upside.
Add in the remarkably-sudden but super-bullish shift in JayPow’s view of US Labor markets (the new “transitory” factors focus), and the potential there to come back online and synchronize with much “sticky higher” Inflation—and you’ve got the makings for a much more abrupt “Fed Tightening” policy inflection.
And with that—SPLAT, with Duration shorts / Bear-Steepeners / Curve-Caps unwound (5s30s cash clobbered and now -46bps flatter over the past 1m), Breakevens compressing violently (5Y BE’s now -36bps over 1m high to low), Commods blasted (Bloomberg Grains Index largest one-day decline since ’09 and -22% over past 1m; Industrial Metals -6% on the week, with a “kiss” from China’s NDRC releasing metals reserves to ease cost pressures) and Cyclical Value / Economically-Sensitive Equities tapped (4 worst S&P sectors yday: Industrials -1.6%, Materials -2.2%, Financials -2.9% and Energy -3.5%).
And again just like last week’s UST / Duration rally, it’s not simply a pure “unwind” of Reflation in isolation—as too, we know that Real $ is implicitly / synthetically “short Gamma” in Duration and acting as forced-buyers into the Treasury rally, off the back of the consensus “underweight” there YTD (UST desk seeing better-buying out of Japan and Asia overnight).
McElligott points out that we have finally reached the long-awaited US Equities quarterly Op-Ex, where we can already see a sharp move lower in $Delta across the key Equities index / ETF options we track, as we finally get a semblance of “Gamma Unclench” today from what has been locking-up the market in a realized volatility smashing chokehold… although true to recent observations, we are still continuing to see willingness to sell vol / supply gamma from clients, most notably seen with “Gamma Hammer” sell strangle flows acting to offset part of the expiration dynamic.
Looking BACKWARDS, the “Vol Smash” has mattered in standard “virtuous feedback loop” fashion—stuffing Dealers with market-pinning (long) Gamma, which then further compresses realized volatility, which then drives Exposure adding from Vol Control / Target Vol / Trend strategies--SPX 1m rVol is now 6.9 (0.4%ile), 3m rVol now 11.5 (0.6%ile).
This double-whammy of 1) “perpetual” Dealer “long Gamma” and 2) concurrent vol-sensitive systematic buying (due to the evisceration of realized volatility in classic “Volatility is your exposure toggle” modern market structure) has generated an estimated +$90.9B of buying from Vol Control over the past 3m; +$55.8B over the trailing 1m; +$41.1B over the past 2w and +$8B over the past 1w.
Of course, the point the Nomura strategist has been making about the go-fwd is that Vol Control then has a lot of fuel to deleverage into a potentially higher realized vol environment or simply larger daily trading ranges--which matters in light of the points surrounding the Op-Ex “Gamma and Delta drop-off” dynamic!!!
Finally, McElligott says it is worth noting some real impulse flows yday on the Vol Desk: 1) BIG buying of Credit downside (Puts and Put Spreads in HYG and LQD) on apparent “Duration-risk” into perceived accelerated Fed tightening cycle; and 2) buying of upside / Gamma in “Rates / Inflation” Sensitive Equities, taking advantage of the pullback (Upside Call / Call Spread buying in GDX, SLV and within Financials / Banks).